6 March, 2018
On 9 January 2017, the Singapore Parliament passed the Securities and Futures (Amendment) Act 2017 (the "SFA Amendment Act") which gave effect to policy proposals aimed at completing the legislative reforms for the regulation of over-the-counter ("OTC") derivatives. The amendments introduced in the SFA Amendment Act seek to implement key proposals recommended by the G20 and Financial Stability Board in 2009. These amendments are not currently in force but are expected to come into operation in the third quarter of this year.
The SFA Amendment Act introduces, among other things, powers to mandate the trading of OTC derivatives on organised markets. To implement those powers, on 21 February 2018, the Monetary Authority of Singapore (the "MAS") published a consultation paper titled "Draft Regulations for Mandatory Trading of Derivatives Contracts" (the "Consultation Paper"), inviting interested parties to provide their comments. The Consultation Paper also includes the draft Securities and Futures (Trading of Derivatives Contracts) Regulations 2018 (the "Mandatory Trading Regulations").
We set out below certain questions arising out of the Consultation Paper, as well as the new Part VIC in the Securities and Futures Act (Cap. 289) (the "SFA").
What is the mandatory trading obligation under the new SFA?
Under the new SFA, a specified person is required to execute a specified derivatives contract on an organised market operated by an approved exchange or recognised market operator.
The form and manner of trading will be prescribed by the MAS although the Mandatory Trading Regulations are presently silent on such requirements.
The MAS may also prescribe other facilities on which mandatory trading may occur.
Who will it apply to?
The mandatory trading obligation will apply to all "specified persons", which is defined to include the following regulated entities:
- banks;
- merchant banks;
- finance companies;
- insurers; and
- holders of a capital markets services licence.
However, the MAS has proposed to limit the initial application of the mandatory trading obligation to only banks above the S$20 billion threshold.
This approach is consistent with the proposed clearing obligation. All other specified persons, including banks below the S$20 billion threshold, will be initially exempted but the MAS will review this and the threshold regularly.
As with the case of clearing, the S$20 billion threshold looks at the aggregate outstanding gross notional amount of the total derivatives contracts (excluding exchange-traded derivatives contracts) booked in Singapore, as at the last day of each of the 4 consecutive calendar quarters.
What types of transaction are subject to the mandatory trading obligation?
The mandatory trading obligation will apply to all "specified derivatives contracts":
- executed on or after the trading commencement date where
- both counterparties are subject to the mandatory trading obligation (i.e. both parties being banks above the S$20 billion threshold).
Specified derivatives contracts refers to derivatives contracts prescribed by the MAS for such purposes, namely the following types of interest rate swaps ("IRS") that are traded in Singapore by both counterparties:
- USD fixed-floating IRS, 2/3/5/7/10 years, no optionality, constant notional
- EUR fixed-floating IRS, 2/3/5/7/10 years, no optionality, constant notional
- GBP fixed-floating IRS, 2/3/5/7/10 years, no optionality, constant notional
The MAS considers these IRS as being "more liquid", and are for tenors traded more significantly by market participants in Singapore.
Detailed contract specifications are set out in the First Schedule to the Mandatory Trading Regulations.
The factors that the MAS will take into consideration in determining whether a type of derivatives contract should be subject to the mandatory trading obligation include:
- the level of product standardisation and liquidity;
- consistency with other jurisdictions; and
- the availability of facilities for the trading of the products.
These factors are set out in greater detail in the new SFA and are broadly similar to those that apply to the clearing obligation.
Finally, it should be noted that the MAS has also proposed consistency between the products subject to the clearing obligation and the mandatory trading obligation. Accordingly, it proposes to subject both EUR and GBP IRS with similar (but not identical) contract specifications to the clearing obligation as well (in addition to USD and SGD IRS).
Traded in Singapore
However, unlike clearing, the nexus requirement proposed by the MAS for the mandatory trading obligation is that the derivatives contract be "traded in Singapore".
In the case of clearing, although the related consultation paper published by the MAS was not very explicit on this point, it is arguable that the MAS' focus was on systemic risks in the Singapore financial system and, accordingly, the nexus requirement was "booked in Singapore" because the place of booking is indicative of where the risks reside. This is similar to the approach taken in the case of margining.
On the contrary, the focus of the mandatory trading obligation is enhancing transparency and providing better information on pricing. In that regard, the global regulatory response was to require mandatory trading of certain OTC products on trading venues. Accordingly, the nexus requirement proposed by the MAS in the case of mandatory trading is "traded in Singapore".
Nevertheless, the "traded in Singapore" nexus requirement does have its own issues. This is exemplified by the reporting rules primarily because it is difficult to operationally monitor when a derivatives contract is traded in Singapore. Further, the mandatory trading obligation only applies if both counterparties trade the swap in Singapore. It is currently unclear how market participants will verify that fact with their counterparty. There is a possibility that market participants may have to "over comply" in the face of ambiguity, or to explore adapting their trading strategies with certain counterparties so that it is clearer whether or not they (or their counterparties) are trading in Singapore.
Are there any exemptions?
The following exemptions have been proposed by the MAS in the Mandatory Trading Regulations:
- Intragroup transactions
- Transactions with certain prescribed public bodies (see below)
- Transactions resulting from a multilateral portfolio compression cycle
- Package transactions (see below)
- Public bodies
The precise list of such exempted public bodies are set out in the Second Schedule to the Mandatory Trading Regulations.
They include:
- the Singapore government;
- statutory boards;
- foreign central governments/central banks; and
- multilateral agencies and organisations such as the Asian Development Bank, the Bank for International Settlements and the International Bank for Reconstruction and Development.
It should be noted that the list of multilateral agencies and organisations is currently inconsistent across the clearing, reporting and margin rules and it appears that the list proposed in the Mandatory Trading Regulations is the most comprehensive to date (being the most recent). It would be important for the MAS to ensure consistency across its rules in this regard.
Package transactions
Although package transactions are expressed to be exempt in the Consultation Paper, there appears to be no express mention of it in the Mandatory Trading Regulations.
It is currently unclear if the entire transaction would be caught by the mandatory trading obligation if one element of a package transaction is subject to that obligation.
When will the mandatory trading obligation apply?
The Mandatory Trading Regulations are expected to be issued at the same time as the new SFA, i.e. in the third quarter of 2018.
The crucial date, however, is the trading commencement date, which will be set out in the First Schedule. In the Consultation Paper, the MAS has indicated that "appropriate time" will be provided so that market participants can make arrangements to access the relevant organised markets and it is hoped that the trading commencement date will provide an adequate transition period for this and, more importantly, take into account the timing of the relevant equivalence determinations.
If, however, you become a specified person only after the trading commencement date (e.g. as a result of crossing the S$20 billion threshold subsequently or the MAS reviewing the thresholds/exemptions), you will have a transition period of 6 months from the date of becoming a specified person to comply.
Will substituted compliance be available?
For US and EU market participants, you may already be subject to mandatory trading obligations in the US and EU respectively , i.e. the USD, EUR and GBP IRS you trade are already subject to mandatory trading obligations in those jurisdictions. However, they will not be subject to the Singapore rules unless they are traded in Singapore by both counterparties.
In the event that they are also subject to the Singapore rules, substituted compliance will be useful. The MAS has indicated in the Consultation Paper that it will seek equivalence determinations for organised markets in Singapore to avoid liquidity fragmentation and it will also continue to actively engage in international and bilateral discussions to address potential concerns on duplicative requirements.
It should also be noted that the Consultation Paper does not explicitly mention which jurisdictions would the MAS regard as equivalent. In the case of margining, the MAS has very helpfully deemed certain WGMR jurisdictions as equivalent pending a formal determination. It remains to seen whether the MAS will adopt a similar approach, noting that certain market participants may already be trading these swaps and they and/or their counterparties may already be subject to the US/EU rules and are therefore trading on the relevant trading venues in order to be compliant with the US/EU rules.
Record-keeping
Similar to the reporting rules, the Mandatory Trading Regulations also require every specified person to ensure that all relevant books and all transaction information be kept for at least 5 years after the last date of the expiry or termination of the relevant contract, agreement or transaction.
The range of specified persons and specified derivatives contracts for the purposes of the Mandatory Trading Regulations will be narrower than that for the purposes of the reporting rules so, in practice, it is likely that you would already be subject to equivalent obligations under the reporting rules (if at all).
Feedback on Consultation Paper
The Consultation Paper and the Mandatory Trading Regulations may be accessed here. There are a list of questions in Annex A to the Consultation Paper on which the MAS has specifically sought views and the closing date for submission of written comments is 23 March 2018. Feedback may also be provided on a confidential basis. If you would like to discuss the Consultation Paper or provide feedback, feel free to reach out to any of your Ashurst contacts.
For further information, please contact:
Kai Loon Loh, Ashurst
kailoon.loh@ashurst-adtlaw.com
